An ideal ratio of 2:1 is generally agreed. If the ratio is higher, 4:1 it could mean that the firm is inefficient and has too much money tied up in stock. On the other hand, a lower ratio value of 1:1 would mean that it may not be able to meet its debts quickly.
The formula is: current assets: current liabilities
if ratio is too high you can sell non-current assets
decrease current liabilities for example, reducing trade credit terms
Acid test ratio
Acid test ratio is a more severe test of a firm’s capabilities to meet its debts. The formula is the same as the but with the added problem of writing off all stock. This is because it assumes that stock:
may be perishable
may go out of date
may go out of fashion or become obsolete
In other words, the firm may be left with stock it cannot sell. An ideal value of 1:1 is generally accepted.
The formula is: (current assets – closing inventory): current liabilities
The two liquidity ratios, current ratio and quick ratio, are designed to answer the question of whether a company has enough short-term assets to cover its short-term liabilities.
Liquidity measures a business's ability to pay all its bills and make loan repayments in the coming months. It is commonly expressed as a ratio. Liquidity compares current liabilities (which are amounts owed within the coming 12 months) against current assets.
Ratio analysis involves the calculation and interpretation of key financial performance indicators to provide useful insights. Financial information is always prepared to satisfy in some way the needs of various interested parties (the "users of accounts").
Introduction: My name is Errol Quitzon, I am a fair, cute, fancy, clean, attractive, sparkling, kind person who loves writing and wants to share my knowledge and understanding with you.
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